PDVSA and the sale of CITGO

05.02.05 | PDVSA, via words of President Hugo Chavez himself, has expressed its desire to sell PDVSA’s affiliate company in the USA CITGO. CITGO is a refining and distribution company. PDVSA has owned all of CITGO since 1989, after purchasing a stake in the company and other refineries in the US in 1986. CITGO was purchased as part of the country’s internationalization strategy of insuring the placement of the country’ oil production in both weak and strong markets. Basically, Venezuela’s oil contains too much sulfur, which in time of low demand implied the country could not find refining capacity for all of its crudes. This created two volatilities for selling the country’s oil: The price volatility and the volatility of not being able to place all of the country’ productions, particularly when prices were low. By purchasing refineries and eventually all of CITGO, Venezuela acquired the capacity to process almost all of its production. Citgo was one part of the internationalization strategy, which was divided worldwide under PDVSA Holdings for the US and a Dutch company, Propernyn, for Europe and the rest of the world.

When Hugo Chávez became President, the whole internationalization strategy was severely questioned. The arguments included that the policy had not been productive for the country in dividends, that Venezuela had been subsidizing US consumers and that it was all invented as a way of stashing away PDVSA’s savings out of the reach of the Government. If the latter had been true, there would have been more straightforward ways of preserving savings, such as buying oil producing or distribution companies elsewhere such as YPF. Instead, PDVSA undertook a very carefully planned strategy of buying strategic properties to guarantee placing the country’s production. It is easy to say now that demand is strong that the strategy was not a good one, but there was a time when it was not trivial for the company to place all of its high sulfur oil production.

Despite the attacks on CITGO, talk of selling it died down, after each of the Presidents’ of PDVSA named by Chávez, defended its presence within the company’s structure. There were rumors in early 2003 that the Government was looking for a buyer, which intensified even further when the company issued debt way ahead of the maturity of the 2003 PDVSA Finance issue, which matured in August 2003. It seemed suspicious to issue notes in February, arguing that part of the proceeds would be used to pay another issue maturing six months later.

The possible sale had been mostly forgotten until this week, when Hugo Chávez himself began making charges which reflect either a lack of information on the subject by those that surround him or his desire to convince the people of the sale using political arguments. All of Chávez’ arguments, from the fact that few Venezuelans work at the company, or that CITGO subsidizes Bush or does not own any of the gas stations are moot. They appear to be excuses to justify the sale politically. PDVSA has never claimed that it owns the CITGO gasoline station network, an investment that definitely could not be justified.

What is not clear is exactly why the Government wants to sell CITGO, other than for political reasons. Does it want to raise the cash or does it want to get rid of a property that could become entangled in lawsuits in the US, but relating to issues here in Venezuela? The only thing that is clear is that the idea has been refloated by the new members of the new PDVSA Board named recently and that the previous Presidents of both PDVSA and CITGO opposed the sale.

Strategically, CITGO may not be as important any longer for Venezuela given the strong oil markets of today, but there is no guarantee that they will remain strong forever and it guarantees the placement of an important fraction of the country’s oil production. Economically, the argument that it is not a good business is hard to believe as the gasoline market is very competitive in the US and prices at the pump level vary very little. CITGO has been paying dividends to PDVSA and in 2003 the company had earnings of US$ 439 million. If there were an ideal buyer, it may also be justified, as PDVSA could sell CITGO and use the money elsewhere, but CITGO has its particular characteristics that make a perfect fir difficult.

The public announcement of the sale will certainly not facilitate executing the sale of CITGO.

Expressing the outright desire to sell it and arguing that it is not a good business publicly, does not appear to be the best negotiating strategy. Additionally, PDVSA holds long term contracts with CITGO that may make the sale quite complex. In the end, it will all be a matter of price. We suspect the Government has an overoptimistic estimate of how much it could fetch for CITGO. A good comparable to CITGO is Valero Energy (itself a company that may be interested) that trades publicly with a P/E of roughly 10, which will give CITGO a valuation of around US$ 5 billion, below the numbers that the Government has been suggesting in private, which range from US$ 7 billion to US$ 12 billion. We suspect these numbers are overoptimistic.

While mostly private companies are mentioned as possible buyers of CITGO, we also suspect that some oil producing countries may be more interested in it as a strategic investment, than private companies. That in itself may force the Government to rethink its strategy of selling the company. What is certainly not very responsible is to say the company is not a good investment, its business is not a good one and gasoline is sold at a discount. This instantly lowers the price you are trying to get for CITGO.

In the end, the sale of CITGO may simply be a way of having PDVSA get the funds to spend in the next year and a half and guarantee Chavez’ re-election in late 2006. If true, it will be a true tragedy for Venezuela, as we will lose both a strategic property for our oil industry and a huge amount of money which will be used to satisfy the political needs of the revolution.